Benefiting from new tangible property regulations and disposal provisions.

• Author: Meyette, Edward D.

A pair of opportunities in the recently issued modified accelerated cost recovery system (MACRS) disposition regulations and tangible property regulations present a significant new benefit for taxpayers. When a taxpayer makes a capital expenditure that results in an improvement to a unit of property, the related project often includes demolishing or removing a portion of the asset being improved. The new MACRS disposition regulations allow a taxpayer to take a loss in this situation by making an election to partially dispose of the asset (Regs. Sec. 1.168(i)-8(d)(2)). A complementary provision in the tangible property regulations gives a taxpayer who has made this election an option to also deduct the removal costs associated with the partial disposition instead of capitalizing the costs as unitary with the improvement (Regs. Sec. 1.263(a)-3(g)(2)).

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Far from an afterthought, the deduction for removal costs often exceeds the loss on the partial disposition. With this in mind, this item discusses how a taxpayer may have both of these benefits limited or lost entirely if it fails to consider them and to perform the required compliance in a timely manner.

Renovation or remodeling projects that give rise to significant partial-disposition losses and removal cost deductions often are multimonth or even multiyear projects, and demolition of the existing property generally is completed early or at the very beginning of the project. This can lead to situations in which a taxpayer performs the removal of the old property in year 1, while the project is not completed and the improvement is not placed into service until year 2 or later. Historically, taxpayers had no compelling reason to consider the proper accounting for such initial costs at the time they were incurred. Prior to the issuance of the regulations, no provision allowed the current deduction of removal costs when a partial disposition occurred. In this situation, removal costs were capitalized to the asset being improved, and the proper classification of the removal costs for tax depreciation purposes was not of consequence until the tax year in which the improved property was placed into service.

Due to the intersection of these timing issues, however, a taxpayer cannot wait until the improvement is placed into service to act if it wishes to take advantage of these new opportunities. If a taxpayer removes portions of an asset in an improvement project during year 1...